Railroad CAPE Ratios – In 1929?

This was a fun paper I sent to The Idea Farm a few weeks ago.  A few tidbits:

Changing Times,Changing Values: A Historical Analysis of Sectors within the US Stock Market 1872-2013

http://ssrn.com/abstract=2447654

“We plot the CAPE ratio for the overall market as well as for the three sectors Industrials, Utilities, and Railroads
in Figure 4. Note that the CAPE ratio of the three sectors shows a relatively similar pattern across sectors through
time, but there are significant differences. Notably, in the 1929 peak, the Utilities sector stood out, because of a sharp  increase in the numerator of the ratio, and Utilities’ CAPE ratio set the all-time high record in the third quarter of that year with slightly more than 60. In that same quarter, the CAPE ratio for the Industrials sector was high, but much less so, only slightly more than 36. In comparison, the Railroads sector’s CAPE ratio at that time was around 20. The other dramatic peak, in the fourth quarter of 1999, was dominated not by the Utilities sector but by Industrials, when the Industrials sector’s CAPE ratio reached nearly 58 then. In comparison, the CAPE ratio for Railroads at that time varied between somewhat more than 30 and approximately 15 and the ratio for Utilities barely exceeded 30 at its peak. The all-time record low in our sample was set by Railroads, in the second quarter of 1932, with the CAPE ratio dropping below 2.5. During that time, Industrials’s CAPE ratio was also low at close to 6 and Utilities’ CAPE ratio came close to 10. We venture that these broad swings in entire sectors of our economy are not entirely due to changes in rational expectations for the future dividends and earnings, and must mean something for subsequent returns.”

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Valuation and Sentiment, You Say Potato…

I had not seen the website Street Talk Live before, but it has some nice charts.  One was a long term chart of the AAII stock allocations.  Nut surprisingly, but sentiment correlates pretty highly with valuations.  But then again both of those are dominated by the P.  

Below I recreated the chart with valuations on the left axis (CAPE), and stock allocation on the right (AAII).  

both

This IS the Global Market Portfolio

Any deviations and you’re an active investor…Rounded these numbers from this earlier piece.

40% stocks (20% US, 20% foreign)

20% Corporate Bonds

30% Government Bonds

5% Real Estate

2% each TIPs, emerging bonds, high yield

 

 

June Tweetstream

Some fun tweets and favorites from the past month over at @MebFaber



zzZZzz Sentiment Update

Below from AAII, or as I like to call this, the Jay Cutler bull market…

 

aaii aaii2

Travel: SF Bay Area

I’ll be in SF next week to speak at Authors@Google on Monday, drop me a line if you’re around!

If You Used Valuation, You Would Be Out of Stocks Since 1993

Let’s say you are a macro value investor, and let’s say you particularly liked using the CAPE ratio.  Well, one argument against CAPE is that is has held an expensive rating on stocks for a looong time.  How long?

Since 1992!  Stocks ended 1992 at a value of 19.8 (prior year was 15.7).  If you were a prudent investor you may have moved your investments into bonds as stocks got expensive, thus missing the massive bull market and looking like a fool for EIGHT years.  You would have looked like a total moron to all of your friends and former co-workers since you would have been fired by 1995.  Many people use this argument as a reason why long term valuation doesn’t work.  

Or does it?

Had you invested in stocks over this period, you would have returned 9.32% per annum, with two whopper bear markets the biggest being a loss of 50%.  Had you moved your money into 10 year bonds you would have done a respectable 6.33%, with a much lower -10% drawdown and a slightly higher Sharpe (cash was an awful 2.82%).

Had you switched back into stocks when they were reasonable (CAPE <20), you would have improved returns to 8.10% with only a 25% drawdown.

So, not at all bad considering you sat out the massive bull, but also sat out the big bears.  

capey

 

But no one says you have to invest just in the US.  That is not your opportunity set.  You have the option to invest in anything in the world.  Houses, baseball cards, wineries in Argentina, etc.  

What if when the US was expensive in 1993, you choose to look abroad and invest in the cheapest countries in the world?  That would have had you investing in countries like Norway, the Netherlands, Spain, and Sweden.  (You may not remember but Norway was the Greece of the early 1990s, hard to imagine but just coming out of a massive banking crisis…)

So, instead, had you invested in the cheapest 25% of countries in the world as detailed in our recent book Global Value (as long as they were below CAPE of 20), and rebalanced yearly, you would have returned 17% per year.  Still a -40% drawdown but that comes with the territory in stocks.  That would currently have you in countries like Brazil, Russia, Greece, and emerging Europe.  That may be a hard thing to do, but what sounds better, investing in a basket of countries trading at a CAPE of 9, or a country in a five year bull market trading at a CAPE of 26?

So, next time someone talks about macro value investing, and how it would have had you out of the US since 1993, tell them that’s a good thing!

 

capey2

 

A Simple Calculation

I think many still do not appreciate the ins and outs of how companies distribute their cash flows.  Our last post included a must read on dividends and buybacks, and below I thought I would include a simple table to illustrate my main point (that ignoring either dividends OR buybacks is a big mistake).

I screened the top 2000 stocks by market cap on Bloomy.  All values are median values below, and I took the top 20% by dividend yield and the top 20% by dividend + net buyback yield. (I excluded debt for the final shareholder yield calc as I’m trying to keep this simple).  Note that the overall dividend yield for the market is about 2.2%, and the highest yielders are at 4.3% – this is what attracts the bees to the honey.  However, what is missed is the net buyback column.  Note that the broad universe, the median stock isn’t buying back any shares, and the dividend stocks are actually net issuers! That is what I like to call sneaky dilution – they pay you dividends with one hand, but issue stock with the other hand.  In fact, of the top dividend stocks, over half are net share issuers…25 over 4%…

Anyways, note the div & buyback column.  These stocks are buying back around 5% of their shares, in addition to the nearly 3% dividend yield.  When you add up all the numbers (which don’t add up exactly as these are median values for each column), you can see why the math makes much more sense when you approach the issue holistically….

 

simple

Breakdown of Dividend, Buyback, and Shareholder Yield for the S&P 500

Below is a great piece from CSFB / Mauboussin on dividends and buybacks that we went out to the Idea Farm a few weeks ago. It is a must read:

Disbursing Cash to Shareholders

1 2 3

 

Santa Barbara Talk

Had forgotten to mention this, but I’m talking at an event in Santa Barbara tomorrow (Tuesday) at 2pm…stop by and pick up a free book!

PowerShares University

SCHEDULE

1:00 PM – 1:15 PM Registration & Lunch

 

1:15 PM – 3:15 PM Presentations

 

Program Eligible for 2.0 Hours of CFP

and Non -IMCA CE Credits

Dividends & Share Buybacks In Portfolio Construction
Nasdaq OMX

The Surprising Alpha from Malkiel’s Monkey & Upside Down Strategies
Research Affiliates
Ari Polychronopoulos, CFA, Vice President, Client Strategies

Momentum-Based Investment Strategies
Dorsey Wright Associates
Andy Hyer, Client Portfolio Manager 

 

INVESCO POWERSHARES HOSTS

Andrew Nelson, Regional Sales Consultant
Adam Kennedy, Regional Vice President


General Information

 

Location

Four Seasons Resort – The Biltmore
1260 Channel Drive 
Santa Barbara, CA 93108

How to get there

Click for directions

 

When

Tuesday, June 03, 2014 1:00 PM – 3:15 PM

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